COLLUSION PRODUCTION ANALYSIS: To avoid competition, oligopolistic firms are occasionally inclined to cooperate through collusion. Collusion occurs when two or more oligopolistic firms jointly agree to control market prices and quantity and to generally act like a monopoly. Colluding firms set a price and produce a quantity that maximizes industry-wide economic profit, the same price and quantity that would be selected by a profit-maximizing monopoly. Once the industry-wide price and production are determined, each individual firm produces the quantity of output that equates the marginal cost of the firm to the marginal revenue for the industry.Collusion production analysis illustrates how two or more colluding firms control market price and quantity to maximize industry-wide profit. This is accomplished by setting industry-wide marginal revenue equal to industry-wide marginal cost. Once the industry-wide profit maximization price and quantity are determined, each colluding firm produces a quantity that equates its own marginal cost with industry-wide marginal revenue. This analysis of collusion production is essentially the same as the analysis of a cartel that maximizes industry-wide profit output and a profit-maximizing monopoly that operates more than one plant or factory. The only difference between these three analyses is the underlying "structure" of the "monopoly." With collusion, independently-owned oligopolistic firms secretly agree to act like a monopoly. With a cartel, independently-owned oligopolistic firms openly agree to act like a monopoly. And with a multiplant monopoly, each "firm" is owned outright by the monopoly. Industry-Wide Marginal Cost CurveThe first step in collusion production analysis is to identify the industry-wide marginal cost. To illustrate how this is accomplished, consider the hypothetical Shady Valley soft drink market, featuring two dueling oligopolistic firms--OmniCola and Juice-Up. To simplify this analysis, assume that the market includes only these two firms.After years of intense, expensive competition, OmniCola and Juice-Up decide to pursue a little cooperation... and a little collusion. They decide to work together, setting a market price and producing a market quantity as if a monopoly controlled the market. The only difference between this collusive "monopoly" and a traditional monopoly is that two separate production "plants" are used, one operated by OmniCola and the other by Juice-Up.
The far right panel is momentarily empty. It is awaiting a key component of this analysis--the industry-wide marginal cost curve. This curve indicates the incremental change in industry-wide production cost for each extra can of soft drink produced. In some cases, the extra can is produced by OmniCola and in other cases it is produced by Juice-Up. In effect, OmniCola and Juice-Up combine their individual marginal cost curves (MCo and MCj) into a single curve. OmniCola and Juice-Up produce cans of soft drink using the firm with the lowest marginal cost. From a graphical standpoint, this is accomplished by horizontally summing the two marginal cost curves. Consider how this works.
Maximizing Industry-Wide Profit
Identifying the industry-wide profit maximization requires the revenue side of the soft drink market. This can be easily accomplished with a click of the [Demand] button. Doing so displays the market demand curve (D) and the corresponding marginal revenue curve (MR). This is the marginal revenue generated as the two colluding oligopolistic firms act like a monopoly. Now, consider how the colluding firms set price and quantity.
The general profit-maximizing formula for colluding oligopolistic firms is: When this condition is satisfied, then total industry profit is maximized. If the industry has more than two firms, then they too must produce output such that their marginal cost is equal to that of every other firm and to the industry marginal revenue. A Little CheatingThe problem with a collusive agreement is that each firm has the incentive to cheat. Consider OmniCola's predicament. At the $1.00, it can increase profit by producing up to 16,000 cans, the quantity at which the $1.00 price intersects its marginal cost curve. Juice-Up can increase profit in a similar manner, by increasing production to 12,000 cans.However, if both firms increase production to a total of 28,000 cans, then the price that buyers are willing to pay declines to $0.50. This price decline then defeats the purpose of colluding. Collusion agreements always face this balancing act. Each firm can do better under collusion than standard competition. However, under the collusion agreement, each firm can do better if they cheat--so long as the other firms maintain the agreement and the higher price. But with every firm motivated to cheat, the agreement is prone to fall apart, returning the firms to the original competitive situation. Check Out These Related Terms... | collusion, efficiency | monopoly, short-run production analysis | game theory | Or For A Little Background... | oligopoly | collusion | explicit collusion | implicit collusion | cartel | market control | oligopoly, behavior | And For Further Study... | kinked-demand curve | kinked-demand curve analysis | Recommended Citation: COLLUSION PRODUCTION ANALYSIS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: May 16, 2024]. |